Monday, April 13, 2015

Why you should be afraid: the next recession is likely to include wage deflation

- by New Deal democratBeginning 3 years ago, I identified poor wage growth as the shortfall in the economy that worries me the most. And it still worries me, even though there has been some modest improvement.

Why? Because unless there is enough of a cushion, the next recession, whenever it comes, there is a significant danger of outright wage deflation. And as we know from the Great Depression, outright wage deflation means that payments on previously contracted debts become, in real terms, higher. This can lead to a vicious spiral of debt-deflation, whereby more and more people fall behind on debt, leading to a further economic contraction, more unemployment, and even more wage deflation, and so the cycle repeats.

So why am I particularly concerned now? Because a decline in wage growth is a feature of virtually all recessions. And we may start the next recession from such a low level of wage growth that the decline in wage growth turns into an absolute decline.

Here's the data. Below is a graph of the YoY% change in average hourly wages (a mean measure) for the last 50 years (blue), and also median usual weekly earnings, a quarterly measure, since the start of the series in 1979 (red):

We are 6 years into this economic expansion. Six years into the last 3 expansions, nominal wage growth already exceeded 3% YoY, and ultimately exceeded 4%. This time, both average and median wage growth is under 2%. Simply put, wage growth is likely to decline by more than that whenever the next recession hits.

More specifically, with only one exception (1974), growth in average hourly wages declined substantially during each recession. Similarly, with one exception (1991), growth in median weekly wages declined substantially during each recession as well. Below I have broken out this data in chart form, showing the pre-recession high and recession or post-recession low in both average and median wages, as well as the net change, for each recession since the start of each series:

Recession

High/low Averagehourly wages

Decline averagehourly wages

High/low medianweekly income

Decline medianweekly income

1970

6.9 / 5.5

-1.4

---

---

1974

6.4 / 5.5

-0.9

---

---

1980

8.7 / 7.1

-1.7

9.5* / 7.1

-2.4

1981-82

9.4 / 1.6

-7.8

9.5 / 3.3

-6.2

1991

4.4 / 2.3

-2.1

5.1 / 2.6

-3.9

2001

4.3 / 1.6

-2.7

6.6 / 1.2

-5.4

2008-09

4.2 / 1.3

-2.9

4.5 / 0.3

-4.2

*Series inception: actual previous high might have been higher

As of now, the highest growth of average hourly wages YoY since 2009 has been +2.5% in August 2014. In 3 of the 7 most recession recessions, growth in average hourly wages have declined by more than that.Even worse, the highest growth of median weekly income since the end of the Great Recession was +2.9% in Q1 3014. In every recession except possibly one since the inception of the series, median wages have dropped by more than 2.9%. In other words, if the next recession has a similar footprint, median weekly income is going to go into absolute decline.

Hopefully this economic recovery continues for quite a while, and hopefully nominal wage growth improves substantially from here. But if it doesn't, or it doesn't improve enough, we are likely to cross from wage growth into wage declines in the next economic downturn, with the distinct possibility of triggering a debt-deflationary spiral.

We barely escaped such a spiral in 2009. Here is an article by Mike Shedlock: Wage Deflation is starting in, from March 27, 2009, listing 14 companies that had announced wage cuts.